Block (NYSE: SQ) reported fiscal 2021 Q4 on Thursday afternoon. The immediate response was muted, but that quickly gave way, as the stock rocketed upwards (more than a 20%) in after-market trading, opening up Friday morning at $112.75, following Thursday’s close at $94.99. To the casual observer, the dramatic rise seemed to be a bit of a head scratcher – not directionally, but in its intensity. In fact, even after reviewing the release and earnings call transcript, it still is. Block performed well, beating on top-line (revenue $4.1B v $4.0 B expected) and bottom-line (adjusted EPS $0.27 v $0.24 expected), and provided positive guidance for the rest of 2022, despite acknowledging an underperforming Q1 which management attributed to Omicron related challenges in January. In my opinion, Block’s solid performance and positive guide did not justify the magnitude of its rise in share price. And as I try to get comfortable with a reasonable explanation for it, I’m forced to return to a long-held belief that too much of Block’s valuation is attributable to investors’ belief in its CEO, Jack Dorsey’s vision, and less so in Block’s core purpose as a financial technology and payments concern. Hence, the question, what is really driving Block’s valuation, Dorsey’s cause, company performance, or some combination of both?
Initially I thought the post-release price-action felt a little “squeezy”, at least that would have made more sense to me. Earnings season for big fintech names has been a virtual blood-bath thus far, starting out with PayPal’s disastrous release on February 1st. But Block’s rip to the upside sustained itself through Friday afternoon, closing out the week at a lofty $119.82.
So, then I went back to the call transcript for a deeper dive into the commentary to see if I missed something. While reading it more closely, it occurred to me that I need to process the transcript wearing two different hats – one (and I believe right one), as an investor, and the second, as a Jack Doresy “believer”, or perhaps more accurately, a minion.
The Company
Block – the company – is executing well. Although management describes the company as having four business units – Square, Cash App, TIDAL, and TBD – I think it’s more appropriate and easier to analyze the company by breaking it down into two core business lines – one that provides payments processing, accounting, and micro-loans to SMBs (Square), and one that provides banking and financial products and services to individual consumers (Cash App). The overarching business thesis is to leverage the two-sided network effect of the two business lines to create a more efficient and disintermediated financial ecosystem. An ecosystem wherein value is enhanced for both types of end-users by eliminating the inefficiencies of the existing banking and payments system, and dislocating the legacy institutions which constitute it – big banks and card networks – using Block’s platform to obviate the need for their existence, and or strip them of their market power if they remain.
And Block is doing this.
From unique users (up) to transaction count (up), from gross payments volume (up) to expanding payment processing services into the larger merchant market segment (merchants with annualized GPV > $500K), Block is getting it done. Perhaps even more impressively on the execution front, Block is getting it done organically – the KPIs from the last quarter do not include the anticipated mega-bounce that management projects to receive from its AfterPay acquisition, which closed in January. And though the AfterPay acquisition, at least on paper, should “juice” Block’s highly sought-after network effect, with the addition of its 122,000 annual active merchants and 19 million annual active consumers, there is a counterargument that the acquisition’s upside potential could be muted. This due to recent buy-now-pay-later headwinds on the regulatory and interest rate fronts, and the economics of the acquisition. Although the deal ultimately went through at $29 B – $10 B less than originally contemplated – some would argue, myself included, that it was a considerable overpay for a non-profitable asset without any truly innovative technology.
The Cause
And yet, going back through the earning’s call transcript wearing my Jack Dorsey “minion” hat, it reads just as powerfully as a call-to-action. From Jack Dorsey’s strongly held belief that Bitcoin is to be the ‘native currency of the internet’, to his articulation of Cash App’s mission – to empower lower income consumers with financial and economic inclusion without being beholden to legacy banking infrastructure – Dorsey sounds like a preacher imbuing his flock with a new world vision of fully democratized finance and banking. Every feature of Cash App is designed to make banking and financial services easier for lower income consumers, from fractional share trading and P2P payments, to the new Cash App Taxes, wherein consumers can file their taxes for free, and have refunds deposited directly into their Cash App wallet.
Dorsey is on a mission to make banking and financial services as ‘easy’ and ‘simple’ as possible, and doing so by inducing end-users to keep all their money in the Block ecosystem. And by extension, not having their money custodied or moved through legacy financial institutions and card networks.
For greater insight into Dorsey’s views of the democratization of financial services, I refer you to this YouTube interview from last July where he shares his thoughts on Bitcoin.
Investment banking take…
My interest in Block, like many other publicly traded financial technology and payments companies, stems from a professional need to understand valuation. And in this particular case, a need to better understand the sustained, meteoric rise in Block’s stock price – up roughly 26% from Thursday’s pre-earnings close.
The rise in stock price, which feeds into valuation, was justified after Block’s positive quarter and guide, but the magnitude of it, at least for me, can’t alone be explained by the KPIs and guidance. There’s another dynamic at work, and it needs to be accounted for.
I believe Block’s valuation is in part, and perhaps to a meaningful degree, due to psychological buy-in from a swath of idealistic investors – most younger ones – who believe in Jack Dorsey’s vision of the future of financial services and banking.
And I’m not suggesting this belief is wrong or misguided.
In fact, to me it’s irrelevant.
But it does need to be accounted for when contemplating Block’s valuation.
One more thought…
On a more philosophical and macroeconomic note – a completely non-investment banking take – there’s a fascinating hypocrisy in what Dorsey preaches and what he’s actually doing. Pursuant to his specific views on Bitcoin, and the decentralization and disintermediation of finance, it follows that he’s attempting to reduce the market power of existing financial institutions and payment schemes.
But Dorsey’s intentionality aside, to a skeptical and even cynical eye, he’s building Block to function in the same way. As such, it ought not be lost on the Block minions that by building an ecosystem whose purpose is to pull-in and capture all the financial means and activity of its end-users, Dorsey’s Block becomes the governing authority of a platform that also has a tremendous amount of market power. One that relies on – and let this also not be lost – the same financial institutions that he proclaims to disintermediate.
In a world where Bitcoin doesn’t become the global currency – and I believe it won’t – fiat transactions will still need to be cleared through legacy financial institutions.
Ever thoroughly read through Square’s General Terms of Service?
The credit and debit card transactions are cleared through JP Morgan Chase and Wells Fargo.
Software and Fintech Investment Banking – NYSE: SQ
